Thursday, June 21, 2012

The Fascinating Balancing Act Of Suggesting Cloud Software To OnPremise Customers

You probably know that SAP sells a lot of OnPremise software and our operating margins are in the high twenties. You can see this in our annual report. We are also one of the largest cloud software providers now. Margins in the cloud software business are not the same as those in the OnPremise software business. This is a balancing act. In the hypothetical scenario where every one of our customers moves to the cloud overnight, our operating margins could become much lower than what it is today. Our investors may not be very happy with that.

This reminds me of a case study that I read while at Columbia Business School. It was about Kodak. Kodak was making film cameras and selling film to consumers at a profit margin of about 60%. Kodak researchers then invented the digital camera which did not need  film and hence provided no additional revenue and high margins. Kodak wanted to preserve those juicy film margins and did not look for a new business model using the digital camera. Kodak eventually lost the lead on cameras and lost an opportunity to reinvent itself.

Apple on the other hand systematically invented the iPad and iPhone that created a new market that instead of killing the personal computer business stimulated it further. Apple went on to become the most valuable company in the world.

At SAP, the story is still unfolding. We are selling a ton of OnPremise software and a ton of OnDemand software. From what I have seen so far, customers with whom I discuss OnDemand software are in no mood to completely give away their OnPremise software. In the case of Human Capital Management for example we have thousands and thousands of customers who use just OnPremise software. They may not give up what they have OnPremise today. But many of them at least in the US and Europe are willing to add OnDemand software to the mix and bring down their overall consulting, maintenance and hardware costs.

Unlike Kodak, at SAP, we are not holding on to our OnPremise business alone. We are actively promoting OnDemand software for many areas. Talent Management is a good example of that. The entire company across ranks has embraced cloud software and strongly believes that cloud is the future.

Interestingly, I find that customers are willing to buy and use both OnPremise and OnDemand software (sometimes doing the same thing) thereby spending more money on licenses with us because in the overall scheme of things they save money on maintenance, consulting and hardware by moving some parts of their applications to the cloud while still having a sense of security and control over areas which they are not comfortable to move to the cloud yet.

We realize this and so are heavily investing in technology, content and services that help make such hybrid situations work for customers. We are also investing heavily in cloud integration services to make this practical and cost effective for customers.

I find this to be a mutually beneficial situation for us as well as our customers. We get to innovate in the cloud without losing our margins overnight and going out of favor with our investors. Customers get to transition to the cloud in a step by step manner without replacing their internal technology teams, without disrupting their business processes overnight and without taking huge risks.

At work, every day is a fascinating balancing act through this innovators dilemma. It will be great if we can pull this off. I am cautiously optimistic. Time will tell.

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